Depreciation of non-current assets

Depreciation --- that part of the cost of non-current asset which is used up during the
process of earning income.

--- allocating / spreading the cost of non-current asset over its useful life.

--- the drop in the value of non-current assets in the process of using
them.

 For proper matching of expenses against the income during a period (Matching
concept) , depreciation should be charged to Income Statement as an expense
to reflect the cost of using the asset.

 All non-current assets with a finite life must be depreciated except:

1) Land --- infinite useful life
2) Investment property --- owned not for use but for investment

Causes of depreciation
1) Wear & tear - through use
2) Passing of time - e.g. leasehold property
3) Obsolescence - through market & technological changes
4) Depletion - through extraction e.g. tin mines

To calculate depreciation, we need to know 4 factors:

1) Cost of non-current asset
2) Estimated useful life of non-current asset
3) Estimated residual value / srcap value of non-current asset
4) Methods of depreciation

Methods of depreciation

1) Straight line method --- an equal amount is charged as depreciation for each
year of the useful life of non-current asset.

Depreciation per year = Original cost – estimated residual value

Estimated useful life

Example: A machine is purchased on 1.1.20x1 for $55,000

Estimated useful life 10 years
Estimated residual value $6,500
 2) Reducing balance method --- A constant % is applied on the carry value of
the non-current assets at the beginning of the
year.
--- Provides higher depreciation charge in the
earlier years of non-current asset’s useful life
& depreciation decreases as the asset ages.

Example: A machine is purchased on 1 May 20x5 for $10,000 cash.

Estimated residual value at the end of useful life = $1200

Depreciation = 20% per annum on the reducing balance method.

Financial year ends on 30 April each year

Calculate: the depreciation charge for each of the year ended 30 April
20x6, 20x7 & 20x8.

Double entry for depreciation on non-current asset

Debit Income statement (annual depreciation) xx

Credit Accumulated depreciation xx

Depreciation provision for assets bought or sold during the accounting year

1) Based on time basis / monthly basis

2) Full year basis --- provide full year depreciation in the year of purchase &
none in the year of sale.

Disposal of non-current assets

£
Example: sales proceeds 10,000
Carrying value 8,200
Loss on disposal 1,800 treated as an expense in the
===== Income statement